Chap. 15 Credit analysis

Question 0

A rating agency monitors:

Answer 0

The credit quality of the issuer and can reassign a different credit rating to its bonds (upgrade or downgrade)

Question 1

A credit rating is a forward looking assessment of:

Answer 1

1. The probability of default

2. The relative magnitude of the loss should a default occur.

Question 2

Before an issue’s credit is changed, a rating agency will place a warning or “watch” that it is reviewing the issue for a potential up or downgrade. T or F?

Answer 2

True

Question 3

What are the “Four C’s” of credit?

Answer 3

Character
Capacity
Collateral
Covenants

Question 4

Character

Answer 4

The ethical reputation, business qualifications-operating record of the board, managent, and execs. responsible for the use of the borrowed funds and its repayment.

Question 5

Capacity

Answer 5

The ability of an issuer to repay its obligations.

Question 6

Collateral

Answer 6

Pledging of traditional assets to secure the debt AND the quality of and value of those unpledged assets controlled by the issuer.

Question 7

Covenants

Answer 7

Imposed restrictions on how management operates the company and conducts its financial affairs.

Question 8

Use of the statement of cash flows.

Answer 8

Used to analyze the ability of an entity to repay its financial obligations and to gain insight into the entity’s financial methods, capital investment strategies and dividend policy.

Question 9

Use of profitability ratios

Answer 9

These help explain the underlying causes of a change in entities revenue.

Question 10

What is the best way to predict future downward earnings?

Answer 10

Through a careful analysis of accounts receivable and inventories; two signs of trouble are a larger than average accts receivable balance and/or bloated inventory.

Question 11

Three indicators to asses entity’s ability to satisfy its debt obligations.

Answer 11

1. Short term solvency ratios
2. Capitalization ratios
3. Coverage ratios

Question 12

Short term solvency ratio

Answer 12

Measures the ability of the firm to satisfy its debt obligations.

Question 13

Capitalization ratio

Answer 13

The extent to which an entity relies on debt financing.

Question 14

Coverage ratio

Answer 14

The ability of the entity to meet obligations brought about by debt financing

Question 15

Better view of entities activities: income statement and

Answer 15

Funds from operations
Operating cash flow
Free operating cash flow 
Discretionary cash flow
Pre financing cash flow

Question 16

Negative covenants

Answer 16

Restrict borrower from taking certain actions such as: various limitations in the company’s ability to incur debt.

Question 17

Two types of interest/fixed charge coverage tests:

Answer 17

Maintenance test = requirement of earnings available to be at least a certain minimum figure.

Debt inccurance

Question 18

Assessing management quality:

Answer 18

1. Strategic direction
2. Financial philosophy
3. Conservatism
4. Track record
5. Succession planning
6. Control systems

Question 19

What are the four informational categories to consider when assessing tax-backed debt?

Answer 19

1. Overall debt burden
2. Ability/political discipline to maintain sound budgetary policy
3. Specific local taxes and intergovernmental revenues available to the issuer.
4. Issuers overall socioeconomic environment.

Question 20

Underlying rating principal for revenue bonds.

Answer 20

Will the project being financed generate sufficient cash flows to satisfy the obligations due bondholders.

Question 21

The principles involved in analyzing the credit risk of a revenue bond are the same as for a corporate bond. T or F?

Answer 21

True

Question 22

In assessing the credit risk for revenue bonds, the trust indenture and legal opinion should provide legal comfort in the following bond security areas:

Answer 22

1. The limits of the basic security
2. Flow of funds structure
3. Rate or user charge covenant
4. Priority of revenue claims
5. Additional bonds tests
6. Other relevant covenants.